community banks, are turning to outside evaluators to determine the value of their borrowers' inventory assets. Previously, many asset-based lenders tended to make loans based on an incomplete picture of a borrower's business gleaned from internal auditors or examiners who were sometimes ill-equipped to evaluate certain types of assets. Given the more competitive nature of the retail marketplace and the need to reduce risk, the market for asset-backed deals in place of unsecured deals is heating up. Today, evaluation and consulting firms are fielding more inquiries than ever from companies such as GE Capital, BankAmerica Business Credit, and TransAmerica Business Credit that want to know their position with retail borrowers in worst-case scenarios. An inventory evaluation delves into critical operational areas. These include receiving, purchasing, advertising, sales promotion, management, store operations, distribution, merchandise selection, vendor structure, markup and markdown policies, merchandise information systems, and customer service as they relate to liquidation values and future business. The evaluator also reviews demographic and psychographic trends in the marketplace, the competition in that class of trade, and the quality of the borrower's own locations. After analyzing this information, it is possible to pinpoint potential trouble spots, highlight areas of positive potential, and recommend specific solutions to individual problems. Outside evaluation firms can enhance audits. Unlike auditors, they have the capacity to evaluate the client's business and inventory through the eyes of retailers, knowing what categories of inventory are returning in the retail and secondary markets today. Their perspective on any retail inventory lending decision can be invaluable because of their liquidation experience, which gives them knowledge completely separate from that of an auditor. As an adjunct to a bank's audits, they give the lender the ability to get its arms completely around an inventory. Each program should get under way with visits to the company's warehouses, distribution centers, corporate offices, and retail stores. Store managers are interviewed. Meetings ensue between representatives of the consultant and the company's chief executive, chief financial officer, general merchandise manager, and other decision-makers. Current inventory is evaluated as to timeliness. Fair market value based on balance is assessed, as well as any critical out-of-stock conditions or any other characteristics of the inventory that would affect the value. The net liquidation value of a target company's inventory located in retail selling locations, distribution centers, and warehouses is estimated by synthesizing the following sources of input: *Visits to retail locations, distribution centers, and warehouses. *Company-supplied information regarding inventory levels. mark-up percentages, departmental categories, and operational procedures. *The consultant's knowledge and experience in determining liquidation values of different types of consumer goods, and the proper amount of expenses associated with inventory disposal. A good cross section of the company's retail outlets and distribution centers should be visited. The reason - discussions with upper management almost always produce rosy pictures of a company's business practices, great excuses for lackluster sales performance, or glowing expectations of new systems to fix current problems. Often the truth is found at the level where the company interacts with the customer. The evaluator should be allowed to ask questions of anyone in the chain of command. Generally, if questions are properly posed, employees can offer great insights into what is good and bad about a company. In fact, they are more likely to give an honest assessment to an outside consultant who promises anonymity than to senior management or a bank auditor. Sometimes the company receives better information about its own practices during this process than would have been the case from studies taking six months or more, and costing many times more. The initial negative reaction the borrower may have to paying for an inventory appraisal, whether direct or indirect, can be many times offset by the invaluable knowledge they receive about the frontline realities of their business. Because of this asset-based lenders and some borrowers alike have found that an evaluator's third-party objectivity in monitoring a client's compliance with future goods and projections can be a helpful tool in ensuring an outstanding loan from developing into a negative situation. If a consumer product's business is closely monitored, there are always indicators that will provide advance warning of impending trouble. Hopefully, if these issues are resolved within a reasonable period, disaster can be averted. One new trend is the appearance of the evaluator at bank syndication meetings, where the lead or agent bank offers pieces of the loan to other lending institutions. Evaluators can deliver an explanation of how they arrived at the values presented in their reports, and also offer real insights into the workings of the company gained during the appraisal inspections. This adds another dimension to these syndication meetings because it offers an unbiased view compared with the "annual report" presentation generally made by senior-level borrower executives. Another benefit is that participant banks get the opportunity to question the evaluator directly, rather than by phone, or through questions relayed later to the lead bank. All this speeds up the decision-making process. Lenders who request an evaluator often include regular monitoring of their client. This is to keep current as to whether stated management financial and operational objectives are being met, and whether any physical, philosophical, or competitive changes have occurred that could affect the values. Regular reviews can provide advance warning before a company reaches a crisis stage, because outside inventory evaluators are sensitive to signs of impending problems. They watch to see that a company is maintaining its traditional quality of inventory, and that the gross margin return on investment remains within acceptable levels. It is always important for any lender to have the inventory monitored relative to sales because of the dramatic effect of fixed costs on inventory recovery if sales and inventory levels fall below formula. Lenders are not omniscient. There is no guarantee that at the end of the line they will be able to reach prudent lending decisions without inside knowledge of a borrower's business. All too often, information gleaned from in-house auditors is superficial or limited in scope, which can result in faulty decisions by asset-based lenders. Banks and other lenders today need all the information they can summon about a borrower's inventory to make more informed lending decisions. Mr. Buxbaum is a principal of BGA Consulting, a unit of Buxbaum, Ginsberg & Associates, based in Encino, Calif.

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